To Limit Corporate Tax Avoidance, Tax Investors

Feb. 15 (Bloomberg) -- Tax avoidance by corporations is on
the agenda for this weekend’s meeting in Moscow of finance
ministers from the Group of 20 advanced and emerging economies.
It is a real problem, and its scale is getting difficult to
ignore. The answer, though, isn’t further tax-code complication,
as some governments favor, but a shift of taxes from profits to
investment income.

To a comical degree, governments are of two minds when it
comes to taxing profits. They have to do it, they say, for
reasons of fairness and to meet their revenue needs. They
deplore the aggressive efforts companies make to lighten the
load. At the same time, governments write tax laws to attract
multinational companies to their jurisdictions. That promotes
the very tax arbitrage they abhor.

This absurdity has reached new heights in countries such as
the U.K., where shaming companies for legal tax avoidance has
become an instrument of tax policy. Starbucks Corp. recently
pledged to make “voluntary” payments to the U.K., after
accounting maneuvers resulted in the coffee-shop owner paying
little or no tax on its British operations for years. The
authorities allege no wrongdoing on Starbucks’s part. After an
outcry in which the government joined, the company agreed to
write checks to Her Majesty’s Revenue and Customs this year and
next.

Populist Campaign

What’s shocking about that episode isn’t that Starbucks
found legal ways to reduce its taxes -- every company does that,
and managers would be failing in their duty to shareholders if
they didn’t -- but that the government allied itself with a
populist campaign to extort money from the company. In a way,
it’s a sign of sheer despair: The tax laws don’t work, so
governments have to try pleading or blackmail instead.

Governments are right about one thing: Corporate tax
avoidance can’t be ignored. The Organization for Economic Co-operation and Development, in a report coinciding with the G-20
meeting, concludes that tax-base erosion is a large and growing
problem arising out of a mismatch of anachronistic tax rules and
economic realities. Tax codes are still grounded in a closed-economy model that the world has largely abandoned.

What’s the answer? There are two basic approaches. One is
harmonization. Governments could aim to coordinate their tax
policies so that legal avoidance is harder. The other is
competition. Let governments’ rivalries for investment drive
corporate taxes ever lower -- until the problem actually
disappears -- and make up the revenue some other way.

Tax competition may sound like anarchy, but there’s more to
be said for it than you might think. International companies
have so much discretion in allocating costs and revenues across
their dispersed units that the corporate tax base is unavoidably
slippery -- all the more so when governments promote that very
slipperiness in an effort to attract investment.

Why fight it? The best strategy to deal with international
tax avoidance is what we have recommended: Cut corporate taxes
and increase taxes on individual investment income (dividends
and capital gains) instead. It’s much harder for individuals to
arbitrage away their tax obligations than it is for companies
operating across borders. This way, corporate profits are still
taxed -- but on a simpler, less distorting basis than the
typical corporate tax code provides.

The main problem with the other approach -- harmonization -
- is that governments are likely to commit to the principle and
then renege. The logic that drives them to attract capital with
tax breaks and then deplore the tax arbitrage that follows isn’t
going away.

Practical Problems

Harmonization, though, appeals strongly to the bureaucratic
mind. An extreme variant of this approach is to create a shared
international tax base. The European Union is exploring this
possibility with its perpetually recycled plan for a “Tobin
tax,” or a levy on financial transactions. The practical
difficulties are so great that the idea is all but inoperable.
The EU is rarely deflected by that consideration.

Many EU members say they won’t go along -- a crippling
defect in itself. But that’s not all. To deal with the flight of
transactions that would tend to nullify a less-than-global plan,
the newest version proposes to tax transactions on EU-issued
instruments worldwide. So U.S. banks would be taxed by the EU
for trading French-issued securities in New York. If you think
that will ever happen, you might be interested in our plan for
mining cheese on the moon.

Governments need revenue, and capital should pay its share.
With that in mind, the best approach to international tax
competition is to let it happen -- and reform domestic codes so
that investment income is brought into the tax base in the
simplest and fairest way.